An appeal to equity: why bankruptcy courts should resort to equitable powers for latitude in their interpretation of 'interests' under Section 363(F) of the Bankruptcy Code.

• Author: Gunlock, Matthew T.

INTRODUCTION

The last several years have witnessed a markedly high number of corporate bankruptcy proceedings, including many high profile petitioners such as Enron, Adelphia Communications, WorldCom and Global Crossing. (1) Record numbers of public corporate bankruptcies were set in 2001 and again in 2002; during this time, 191 such companies filed for bankruptcy protection. (2) The bankruptcy process often involves the sale of corporate assets to raise money for creditors of the business, and the Bankruptcy Code (3) offers two means by which a debtor or trustee may sell business assets: sections 363(b) and (f), (4) which govern sales prior to approval of a reorganization plan, and sections 1123(a)(5)(D) (5) and 1141(c), (6) which govern sales made pursuant to a reorganization plan. Debtors and trustees most often prefer a pre-plan sale under [section] 363 because in comparison to sales pursuant to a reorganization plan, pre-plan sales impose the Bankruptcy Code's minimum notice and hearing requirements and, accordingly, are usually quicker and less expensive. (7)

Section 363(f) of the Bankruptcy Code provides a mechanism by which a debtor's assets may be sold "free and clear of any interest in such property." (8) Such a "free and clear" pre-plan sale under [section] 363(f) not only saves time and money in terms of decreased notice and hearing requirements when compared to a sale pursuant to a reorganization plan, (9) but it also provides a valuable means to raise funds for the debtor because a purchaser of bankruptcy assets will pay more for the assets when they are sold without the risk of successor liability. (10) Accordingly, the purchaser, debtor, creditors, and general public are beneficiaries of the "free and clear" sale process under [section] 363(f). There has been ample debate, however, with respect to what constitutes an "interest" within the meaning of [section] 363(f). (11)

It has been argued that bankruptcy courts and other courts have adopted a far too expansive view of what falls within the definition of an "interest" and have thereby impermissibly extinguished certain claims that might otherwise be rightfully pursued against the purchaser of the bankruptcy assets. (12) In contrast, others have argued that successor liability in the context of [section] 363(f) amounts to a regulatory taking in violation of the Takings Clause of the Constitution and that "interest" should be construed broadly. (13) Case law has provided little guidance as to whether the narrow or expansive interpretation of "interest" is more compelling. (14) A proponent of either side of the argument has little difficulty in marshaling decisions supporting his particular view of what interpretation is proper, and there is currently a marked split in the bankruptcy courts and courts reviewing their decisions. (15)

The importance of determining whether an item falls within the definition of "interest" according to [section] 363(f) cannot be overemphasized. A specific court's interpretation of what constitutes an "interest" can mean the difference between the termination of a plaintiffs claim against a successor purchaser and unbounded successor liability for the purchaser of the bankruptcy assets. As sales pursuant to [section] 363(f) become more widespread as a means to liquidate debtors' assets quickly and efficiently without having to satisfy the extensive requirements of developing and implementing a reorganization plan under other provisions of the Bankruptcy Code, (16) the importance of resolving the uncertainty will grow increasingly acute. Some courts have found certain liabilities to be categorically unseverable from purchased assets. (17) Other courts have allowed all liabilities to be severed from the debtor's assets, regardless of character. (18) Still other courts have permitted successor liability in some circumstances while disallowing it in others by finding subtle distinctions between facially similar cases. (19)

A recent Third Circuit decision, Equal Employment Opportunity Commission v. Knox-Schillinger (In re Trans World Airlines, Inc.), (20) exemplifies the friction that plagues the interpretation of what constitutes an "interest" under [section] 363(f). This Note utilizes that case as an example for purposes of discussing the matter and for recommending a case law-driven means to minimizing some of the confusion in the interpretation and the application of [section] 363(f). Part I supplies a contextual background to In re TWA. Part II discusses [section] 363(f) generally and identifies the problems of statutory construction that have led to the controversy in its interpretation. Part III analyzes the reasoning of In re TWA, focusing particularly on the Third Circuit's broad interpretation of "interest" in contravention of the plain language of [section] 363(f). Part IV suggests that the result in In re TWA, although beyond the scope of the plain language of [section] 363(f), was based on the court's balancing of equitable circumstances within the case and when read in that context, was the correct result. Part IV contends further that bankruptcy courts and reviewing courts ought to ground such equity balances within preexisting equitable powers provided by the Bankruptcy Code rather than in amorphous discussions of public policy. This Note concludes that such an approach would do less violence to the plain language of [section] 363(f) than the practice used by the In re TWA court and those courts following similar approaches, while still maintaining ample flexibility for courts to serve the overall interests of the Bankruptcy Code.

1. PRELUDE TO A CONTROVERSY: THE PRE-PETITION SALE OF TWA ASSETS TO AMERICAN AIRLINES

   On January 10, 2001, Trans World Airlines (TWA) filed a Chapter 11 bankruptcy petition. (21) The United States' eighth-largest airline at the time, TWA had not earned a profit in more than ten years. (22) In the spring of 2000, TWA determined that it could not continue to operate independently and the company subsequently sought to enter a business combination--such as a merger with, or sale of assets to--a competing airline. (23) Throughout 2000, TWA was engaged in discussions with American Airlines regarding the formation of a prospective strategic partnership. (24)

   A week after proposing to purchase TWA's assets, (25) American Airlines agreed on January 9, 2001, "to a purchase plan subject to an auction and bankruptcy court approval." (26) Although TWA's assets were to be sold pursuant to a public bidding process, as of the deadline for the submission of bids, only American Airlines had offered an order-compliant bid. (27) The Board of Directors of TWA accepted American Airlines' proposal to purchase TWA's assets for $742 million. (28)

   American Airlines purchased TWA's assets through a pre-petition sale process in accordance with the terms of [section] 363(f) of the Bankruptcy Code, (29) which allows for assets in bankruptcy to be sold "free and clear of any interest in such property" assuming certain preconditions are met. (30) Essentially, if the requirements of [section] 363(f) are satisfied, the bankruptcy court has the authority to sever "interests" from the assets so that the purchaser can take possession of them without fear of successor liability for such "interests."

   The interests at issue in the In re TWA case were travel vouchers granted to TWA employees pursuant to the settlement of two class action lawsuits. (31) The first suit claimed that TWA's maternity leave policy had violated Title VII of the Civil Rights Act of 1964. (32) The second suit involved twenty-nine discrimination claims that had been filed against TWA with the Equal Employment Opportunity Commission (EEOC) alleging violations of several federal employment discrimination statutes. (33) In approving the sale order conveying the assets of TWA to American Airlines, the bankruptcy court determined that [section] 363(f) had been satisfied and that there was no basis for successor liability attaching to American Airlines. (34) The United States District Court for the District of Delaware affirmed the bankruptcy court's order extinguishing the claims. (35) The United States Court of Appeals for the Third Circuit subsequently affirmed the district court's decision. (36)

   The Third Circuit's opinion likely will face ample scholarly criticism for its extremely broad interpretation of what constitutes an "interest" within the meaning of [section] 363(f). (37) Before discussing why the decision to strip the travel voucher and EEOC claims from TWA's assets, thereby precluding such claims from being enforced against American Airlines, will be subject to a high degree of criticism, it is worthwhile to discuss [section] 363(f) in a general sense to garner an overview of its basic doctrinal background.

2. SECTION 363(f): EXPEDIENT SALE MECHANISM OR A MEANS TO CIRCUMVENT VALUABLE PROVISIONS OF THE BANKRUPTCY CODE?

   The sale of assets under the authority of [section] 363 of the Bankruptcy Code has become an increasingly important aspect of Chapter 11 filings. (38) The incidence of bankruptcy reorganizations has increased in the past several years in the wake of the September 11 terrorist attacks (39) and much ballyhooed corporate governance scandals (40) including--among others--Enron, WorldCom, Adelphia Communications, and Global Crossing. (41) The costs associated with the development of a reorganization plan and a disclosure statement often push debtors in the direction of an asset sale as a means of maximizing asset value and quickly satisfying outstanding debts. (42) Pursuant to [section] 363 of the Bankruptcy Code, if the trustee is authorized to operate the business of the debtor, the trustee may enter into transactions, including the sale or lease of property of the estate, and may use property of the estate, in the ordinary course of business, unless the court has ordered otherwise. (43) The trustee may conduct...